BREAKINGVIEWS-Ivory tower barbarian now pounds at the gate

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(The author is a Reuters Breakingviews columnist. The opinions
expressed are his own.)

By Richard Beales

NEW YORK, Aug 16 (Reuters Breakingviews) - There's an ivory
tower barbarian at the gate. Lucian Bebchuk, a Harvard Law
School professor, is ratcheting up his battle against corporate
defenders like veteran lawyer Martin Lipton. Hedge fund bosses,
including Dan Loeb and Bill Ackman, expose real management
weaknesses. Even without their resources, though, academic
activists like Bebchuk can still be on target.

The spat between Bebchuk and Lipton seems as personal as the
one that erupted recently between Ackman, the founder of
Pershing Square Capital Management, and billionaire Carl Icahn.
Lipton reckons Bebchuk has "aided and abetted" uppity investors
in "a form of extortion." Bebchuk, with the aid of two
colleagues, fired back in a study that undermines Lipton's credo
that activists create only short-term share price pops.

The decades of experience logged by the founding partner of
Wachtell, Lipton, Rosen & Katz shouldn't be dismissed, but just
as Bebchuk may favor the idea of shareholder democracy, Lipton
has long sought to insulate managers from the demands of
investors. He sees activism as damaging to a company's long-term
prospects even though Bebchuk's research addressed Lipton's
concern that previous analyses didn't extend far enough beyond
an activist's initial appearance.

In a note to clients on the topic last week, Lipton said he
didn't think Bebchuk sufficiently made his case on activists and
long-term value. Other academic work has suggested activism may
bring little if any benefit or that any share price gains may be
limited to cases where companies end up being sold. Even that
outcome, though, is still good for shareholders of the acquired
companies. And few if any studies seem to support the contention
that activists do long-term operational harm.

Modern-day hedge fund interventions can be relatively tame.
For instance, Loeb of Third Point recently proposed that Sony
(6758.T) spin off its entertainment arm, which he considers
undervalued. The company declined, but commitments to
transparency – and probably greater focus on the issue behind
the boardroom doors – may well ensure Loeb's investment remains
in the black for the long term, to the benefit of all
shareholders in the Japanese conglomerate.

Activists have also recently tackled instances of strikingly
weak governance at companies like Chesapeake Energy (CHK.N) and
SandRidge Energy (SD.N). Even Hess (HES.N), which largely fended
off Elliott Management, bowed to some of the hedge fund's
demands. In some cases, as Lipton has noted, activists cheekily
push for changes already under way. In others, chief executives
quietly adopt ideas while publicly rejecting them. Such
distinctions needn't matter: sound strategic decisions can bring
gains for all shareholders.

Lipton's latest missive subtly shifts the debate by
suggesting that activism is but a single facet of a bigger trend
toward short-termism in corporate America, one that damages
economic growth, competitiveness and employment. That's a
broader argument involving – as he recognizes – legislators,
regulators and the entire structure of the investment industry.
The general logic can hardly be the thrust of Lipton's advice to
clients. Boards of directors need to know what's best for their
shareholders, and in this realm Bebchuk's evidence is looking
stronger.

Activists don't always play cleanly, of course. For
instance, the Children's Investment Fund violated U.S.
disclosure rules in its fight with railroad operator CSX (CSX.N)
five years ago. Moreover, sometimes there are signs of special
treatment that doesn't benefit all shareholders. Third Point's
partial exit from its investment in Yahoo (YHOO.O) last month
looks a case in point.

Lipton also has reasonably criticized activists who pay
their sponsored directors large bonuses for achieving quick
stock price gains. These special arrangements align one
boardroom faction with the short-term interest of a specific
shareholder.

If that kind of distortion can be avoided, however, hedge
funds willing to go to the trouble and expense of taking company
bosses to task help solve the agency problem so common in public
companies. Because ownership is often both fragmented and
intermediated by money managers, most shareholders can't or
don't have enough incentive to act like owners.

That in turn permits boards and managers to become
complacent. Any CEO worth his generous compensation package
should, along with his board, be willing to listen to a big
shareholder's ideas for improvement. Sheltering managers and
directors, as Lipton advocates, makes that less likely. He has a
point about the bigger questions. When it comes to activism,
though, Bebchuk has Lipton on the back foot.

- Lucian Bebchuk, a Harvard Law School professor, wrote in
the Aug. 7 edition of the Wall Street Journal that hedge fund
activists bring long-term shareholder gains at companies they
target, not just short-term spikes in stock prices that then
fade away.

- Bebchuk's article was based on a study he conducted with
two other academics, finding that "the claim that interventions
by activist shareholders, and in particular activist hedge
funds, have an adverse effect on the long-term interests of
companies and their shareholders ... is not supported by the
data."

- The research covers 2,000 cases of hedge fund activism
between 1994 and 2007 and evaluates the operating performance of
the companies involved for five years after activist investors
showed up. It found improvements in long-term performance beyond
the standard early stock price jump.

- A prominent proponent of what Bebchuk calls the "myopic
activists" claim is lawyer Martin Lipton of Wachtell, Lipton,
Rosen & Katz. In March, he wrote in a Harvard Law School forum
that activist hedge funds "are preying on American corporations
to create short-term increases in the market price of their
stock at the expense of long-term value," calling this "a form
of extortion."

- In another post in February, Lipton criticized what he
called the "attack" by activist hedge fund manager David Einhorn
on Apple (AAPL.O), calling it a "clarion call for effective
action to deal with the misuse of shareholder power." He singled
out Bebchuk as leader of a "cohort of academics" who have "aided
and abetted" activists.

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